Institutional Investors, Pension Funds, Private Equity

PE Surveys: Investors, Managers Diverge on Due Diligence; Firms Target Divestment  

Fund managers and asset owners are not totally aligned in their views of what factors about managers are important in a private market due diligence process, according to eVestment’s recently released Private Markets Due Diligence Survey 2018. Meanwhile, EY’s Global Private Equity Divestment Study, released last week, finds that PE firms continue to focus on exits, which were up 10% in 2017.

The eVestment survey indicates that valuations of portfolio companies are a top concern this year among 60% of the private equity investors and their consultants that responded to the survey. Dry powder (cash available for investment) was the No. 2 top concern, with 40% of this group citing it as among their top concerns for the industry this year. Both results are up substantially from 2017, when 48% of investors and consultants cited valuations and 26% cited dry powder as their top concerns.

“The rigor institutional investors are exerting in the due diligence process in the private markets space, even during a time of unprecedented demand, is undeniable and it’s interesting to see how investors, consultants and managers are adapting and the tools and solutions they are adopting as this evolution continues,” Graeme Faulds, director of product, eVestment Private Markets, observed in a released statement.

“Managers, investors and consultants perceived ‘team’ as the most important aspect of due diligence on a fund, yet it was interesting to note that investors and consultant placed greater relative importance on ‘strategy’ than managers did. Conversely, fund managers perceived ‘market opportunity’ to be more important than ‘strategy’, Faulds writes in introductory comments to the report.

eVestment has conducted the survey of investors and consultants worldwide for the past three years. But this year, for the first time, it also surveyed private markets fund managers seeking insights on the market. The survey finds that while valuations and dry powder also topped the list of fund managers’ concerns, the proportion of respondents that noted them as such was lower than investors and consultants, at only 38% and 19%, respectively.

Nevertheless, even with concerns regarding the level of dry powder, 21% of respondents indicated they still expect to increase their allocations to private equity.

Future performance was raised as a concern by fewer investors and consultants than last year, at 7% compared to 14%, and only 5% of fund managers believed it to be a concern. This is surprising given that high valuations and an excess of capital in the market would be expected to impact returns and therefore future performance, according to the report.

The report suggests that the finding perhaps illustrates fund managers’ confidence in their ability to maximize returns through hands-on operational improvements, rather than relying on market timing.

Another key finding from the report is that twice as many investors and consultants as fund managers regard back-office operations as a key aspect of due diligence, and it is more common place to find some larger groups establishing dedicated operational due diligence teams separate from their investment due diligence teams.

This year, 36% of investors and consultants responded that they never or rarely trust the performance data provided by fund managers. Some of the reasons respondents gave for this view included a distrust of unrealized valuations during fundraising and the experience of finding errors.

Managers, investors and consultants perceived ‘team’ as the most important aspect of due diligence on a fund, yet it was interesting to note that investors and consultant placed greater relative importance on ‘strategy’ than managers did.

This probably explains why when surveyed on their frequency of recalculating fund managers’ track records, 75% of investors and consultants stated that they recalculate performance numbers more often than not. This is consistent with eVestment’s previous surveys, it says. These results also tie with the view expressed by 78% of fund managers that “Investors are demanding increasingly granular performance data compared to previous years.” Seventy four percent of investors and consultants stated that they always or often recalculate fund performance numbers.

Managers, investors and consultants perceived “team” as the most important aspect of due diligence on a fund. But investors and consultants placed greater relative importance on “strategy” than managers did. Conversely, fund managers perceived “market opportunity” to be more important than strategy, according to the report.

Although one in four investors and consultants cited fees as a key area of focus during the due diligence process, it did not feature as an area of concern for the year ahead.

Where’s the door?

According to EY’s PE divestment study, just over half (51%) of PE executives that participated say their firm has made five  to 10 divestments in the past three years, up from 32% last year. “This elevated level of activity has allowed many to improve their strategic and data-driven exit preparation practices at every stage of the deal,” the study says, noting that 2017 was a record year for PE exits, with nearly 2,500 global exits worth almost $535 billion, more than any year since 2007.

Other key findings of the report include:

  • 94% of responding PE firms say they will use more predictive analytics within the next two years.
  • 83% are seeking out operating partners with digital or technical expertise.
  • 43% say organic growth potential is one of the top considerations for their exit strategy.
  • 76% say digitalizing the portfolio company ahead of an exit helps demonstrate a stronger value creation story.
  • 61% now initiate a divestment 12 months before sale, up from 35% in 2017.
  • 68% say they used analytics during buyer negotiations.

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